Morning Report: Tax reform passes 12/4/17

Vital Statistics:

Last Change
S&P Futures 2657.5 13.5
Eurostoxx Index 388.0 4.0
Oil (WTI) 57.8 -0.6
US dollar index 86.7 0.3
10 Year Govt Bond Yield 2.39%
Current Coupon Fannie Mae TBA 102.625
Current Coupon Ginnie Mae TBA 103.625
30 Year Fixed Rate Mortgage 3.88

Stocks are higher this morning after tax reform passes in the Senate. Bonds and MBS are flat.

This week should be pretty quiet with the exception of the jobs report on Friday. We are in the quiet period ahead of the FOMC meeting next week, so we won’t be getting any Fed-speak.

Tax reform passed over the weekend in the Senate. Now comes the reconciliation between the House and Senate versions. The winners in this bill? Banks, as they generally have fewer deductions and end up paying the high statutory rate. The corporate AMT remains at 20%. The losers? Health insurance companies that will see the healthier and younger eschew health insurance because the mandate is gone. Note however that the penalty for not carrying insurance under Obamacare was pretty small to begin with – so it probably won’t make that big of a difference when all is said and done.

One potential wrinkle in the tax reform bill seems to have been fixed, and that is the treatment of mortgage servicing rights. The tax bill would have made mortgage servicing rights taxable upon creation, which would have been negative for smaller independent mortgage originators. It looks like there was an amendment to eliminate this. Like many things in the tax bill, it will take some time to digest what the provisions were.

Note that while the stock market has cheered tax reform, bonds and currencies are largely ignoring it. Good news for originators who don’t need higher rates. It is early days, however.

Stocks on Friday had a swoon mid-day on an ABC report that Mike Flynn was directed to make contact with the Russians. This was supposedly the smoking gun in the Trump – Russia collusion story. It turns out that Flynn was told to make contact after the election, which is what you would expect to see from an incoming administration in transition. The reporter from ABC was suspended for the story, although it certainly gave stock investors heartburn for a day.

One columnist is a bear on the builders after tax reform. FWIW, I think that the absolute dearth of inventory will dominate any secondary effects from the tax bill. He notes that household formation did lag for the Millennial generation, and that student loan debt is an issue. That said, the financial difference between renting and buying is still very favorable towards buying given that interest rates are low and rental inflation is high. Second, the economy is accelerating (the Atlanta Fed just took up its estimate for Q4 GDP to 3.5%) and wage inflation seems to be coming back. The article does make a good point: that the homebuilding business is highly cyclical – and during booms P/E ratios will compress. That said, we haven’t had a homebuilding boom in 12 years, which is a long, long time.

Morning Report: Corporate taxes and inflation 12/1/17

Vital Statistics:

Last Change
S&P Futures 2645.0 -3.0
Eurostoxx Index 386.0 -0.7
Oil (WTI) 57.8 0.4
US dollar index 86.8 0.1
10 Year Govt Bond Yield 2.39%
Current Coupon Fannie Mae TBA 102.625
Current Coupon Ginnie Mae TBA 103.625
30 Year Fixed Rate Mortgage 3.88

Stocks are falling victim to profit-taking (and possibly window-dressing) on the first day of the month. Bonds and MBS are up.

Manufacturing slipped in November, according to the PMI Manufacturing Index. The ISM Manufacturing index moved slightly lower as well.

Construction spending rose 1.4% MOM and 2.9% YOY in October.

Negotiations continue on tax reform as Republican Senators made a lot of progress overnight. Issues about a financial trigger are separating fiscal hawks from conservatives. Probably the best summation of play:“We’re trying to get to a point where nobody is going to get exactly what they want but enough to get the bill passed,” Senator Thom Tillis of North Carolina said. Republicans need to have something to show in 2018, and this is something. At the end of the day, it will probably be more symbolic than substantial, at least on the individual income tax front. Cutting corporate taxes will almost certainly help the economy however.

Here is the thing to keep in mind about corporate taxes: Transfer pricing matters. Transfer pricing is how firms with international arms allocate revenues and expenses. For example, expenses like investor relations, legal, etc are used by the international arms as well and some of those costs should be allocated to them. If the company has operations in high tax and low-tax jurisdictions, they have the incentive to allocate all of their costs to the high tax jurisdiction and all of their revenues to the low tax jurisdiction. This minimizes US income and maximizes foreign income which results in companies making low payments to the IRS and high payments to foreign tax authorities. The US tax code effectively subsidizes foreign governments! It also locks up cash overseas, as companies have to pay US tax on that income once it is repatriated, which is even more of an incentive to shift earnings overseas. We have the highest corporate tax rate in the world, but the effective US tax rate is about what everyone else pays. If we equalize our corporate tax rate to the rest of the world, that incentive to play games with revenue and expense goes away. Which is why you could, at the margin, see revenues increase despite cutting corporate taxes.

After tax reform, the focus in Washington turns to funding the government. Democrats are demanding action on immigration in exchange for yes votes on a continuing resolution. For all the posturing over these things, they invariably get resolved.

Booms don’t last forever, and neither do busts. After experiencing a generation of deflation, Japan is beginning to see the stirrings of inflation. Imported deflation from Asia has been a bit of a free lunch for the US as it allowed the Fed to be about as easy as it wanted without triggering inflation – at least inflation as measured by the Consumer Price Index. IMO, if Japan is recovering for real, and the Chinese economy maintains strength (i.e. their real estate bubble doesn’t burst) then inflation is probably set to return. A Japanese recovery is a bit of a sea change for the Fed, and the return of the world’s second biggest economy will gobble up the glut of capacity we currently have. This could force the Fed to act more quickly than it otherwise would.

What does inflation mean for the US? First of all, more consumer comfort. An economy with low inflation and low wage growth is much more uncomfortable than an economy with moderate inflation and moderate wage growth. While this may seem counter-intuitive (if wages and prices are rising together, who cares what the rate is?) it matters because of debt. Rising wages and prices means that the relative size of a household’s debt decreases over time. While this won’t necessarily apply to floating rate debt like credit card debt, it will apply to things that are fixed, like car loans, student loans, and mortgages. Worries about 1970s style hyper-inflation in the US are also overblown. That phenomenon was largely due to the oil shocks and a host of other issues (capacity constraints) that are no longer applicable.

Of course what is great for a borrower is necessarily bad for a lender (or people who own long-duration assets, like banks and insurance companies). I wouldn’t rule out a hiccup in bank earnings or insurance company earnings, but I can’t see anything systemic like we had in 2008. I do wonder how much this will affect the $4.5 trillion of assets owned by the Fed.

Overall, higher inflation will be good for the real estate market, as it means higher prices and higher employment. Higher inflation is most beneficial to the first time homebuyer.

Morning Report: Personal Income rises 11/30/17

Vital Statistics:

Last Change
S&P Futures 2633.3 8.3
Eurostoxx Index 389.2 1.2
Oil (WTI) 57.8 0.5
US dollar index 86.8 0.1
10 Year Govt Bond Yield 2.39%
Current Coupon Fannie Mae TBA 102.625
Current Coupon Ginnie Mae TBA 103.625
30 Year Fixed Rate Mortgage 3.88

Stocks are higher this morning as tax reform looks more likely. Bonds and MBS are flat.

Initial Jobless Claims fell 2,000 last week to 238,000.

Personal incomes rose 0.4% in October and personal spending rose 0.3%. The savings rate ticked up to 3.2%.  Inflation remains in check, with the core rate rising 0.2% MOM and 1.4% YOY. It probably won’t make any difference to the Fed, which is pretty much set to hike interest rates next month for the second time this year.

The core PCE (the inflation measure preferred by the Fed) has been pretty much below the Fed’s target for almost a decade, except for a blip in 2012.

Tax reform has begun debate and some hope to see a vote in the Senate tonight. One of the biggest sticking points is the idea of a trigger, which would increase taxes if there is a revenue shortfall. We have had all sorts of spending triggers before (the Medicare “doc fix” is the classic one), but they invariably get ignored. Here is the issue with a revenue trigger. Suppose the US enters a recession, and revenues fall (as they almost always do). The bill would require the government to hike taxes in response, which is exactly the wrong thing to do as it adds another drag to the economy. In other words, it would never happen. Again, I am skeptical that such a large undertaking could be done on a tight timeline without much debate, but you never know.

Morning Report: New FHFA limits 11/29/17

Vital Statistics:

Last Change
S&P Futures 2627.8 3.0
Eurostoxx Index 386.4 1.5
Oil (WTI) 57.6 -0.5
US dollar index 86.5 0.0
10 Year Govt Bond Yield 2.37%
Current Coupon Fannie Mae TBA 102.938
Current Coupon Ginnie Mae TBA 103.75
30 Year Fixed Rate Mortgage 3.89

Stocks are higher this morning on overseas strength. Bonds and MBS are lower.

The second estimate for third quarter GDP was revised upward from 3.0% to 3.3%, in line with expectations. The price deflator was revised downward by 10 basis points to 2.1% and spending was revised downward as well.

Mortgage Applications fell 3% last week as purchases rose 2% and refis fell 8%. There was an adjustment for the Thanksgiving Day holiday. Rates were more or less unchanged.

Corporate Profits rose 10% in the third quarter, an improvement from the 7.4% increase in the second.

Bitcoin hit $10,000 last night, and is a fascinating Rorsach Test for one’s political and monetary views.

The FHFA increased their conforming loan limits to $453,100 yesterday and the high balance limit to $679,650.

Growth is accelerating not only in the US, but globally as well. Goldman and Barclay’s are forecasting that global growth will hit 4% next year, the highest since 2011. Strategists are betting that Japan (the second biggest economy) has finally turned the corner, at long last. This will probably not be great for interest rates however. That said, until inflation returns, slow and steady increases will be the name of the game and the origination business might still do just fine as a wave of first time homebuyers enter the market.

Last night a Federal Judge denied the CFPB’s request for a temporary restraining order to prevent Mick Mulvaney from assuming the role of acting director for the CFPB. His first act was to institute a hiring freeze and a moratorium on new regulations.

Jerome Powell faced the Senate yesterday, and for the most part things stuck to script. He said that the case was strong for a rate hike in December, but he didn’t offer much in the way of specific policy guidance. Many Senators wanted him to opine on tax cuts, but Powell wouldn’t go there.

The MBA is calling on the Senate to change a provision that requires lenders to pay tax on the mortgage servicing right up front, even though it is a non-cash item. It wasn’t specifically directed at MSRs – it was directed at anything that is an accrual. The fact that independent mortgage originators have accumulated so much servicing has bothered many in DC, and this provision would probably encourage more of them to sell servicing to the big banks. It won’t be good for MSR valuations, that is for sure. The MBA makes this point, and also says that small independent originators will have a more volatile income stream, as an MSR portfolio has a counter-cyclical effect on the mortgage origination business. I don’t think this was necessarily a policy intention and it is an excellent example of why you don’t push through tax reform on an expedited timeline without public comment, etc.

NAR is out with their “game changers for 2018.”  They are predicting that supply will finally begin to catch up with demand and that home price appreciation will moderate. The effect will be felt at the middle to high end ($350k+) range as that is where the building has been and demand for starter homes will only increase as the Millennials age and get jobs. Tax reform will have a potential impact, however that will only be at the higher tiers.

Morning Report: Jerome Powell testifies in front of the Senate 11/28/17

Vital Statistics:

Last Change
S&P Futures 2604.8 3.0
Eurostoxx Index 386.4 1.5
Oil (WTI) 57.6 -0.5
US dollar index 86.5 0.0
10 Year Govt Bond Yield 2.32%
Current Coupon Fannie Mae TBA 102.938
Current Coupon Ginnie Mae TBA 103.75
30 Year Fixed Rate Mortgage 3.89

Stocks are up this morning on no real news. Bonds and MBS are up small.

Jerome Powell will testify in front of the Senate today. Here are his prepared remarks. With respect to monetary policy, he had this to say: “If confirmed, I would strive, along with my colleagues, to support the economy’s continued progress toward full recovery. Our aim is to sustain a strong jobs market with inflation moving gradually up toward our target. We expect interest rates to rise somewhat further and the size of our balance sheet to gradually shrink.” He discusses the dual mandate, and his interpretation of that: “maximum employment, meaning people who want to work either have a job or are likely to find one fairly quickly; and price stability, meaning inflation is low and stable enough that it need not figure into households’ and businesses’ economic decisions.”

In other words, he is pretty much going to vote to continue the same path of Janet Yellen and Ben Bernanke. He thinks inflation is too low, and we are not yet at full employment. However, we are closer to our goals and therefore it is time to remove some of the emergency measures we took during the crisis. Monetary policy is not going to become more hawkish in any meaningful way.

On the regulatory front, he had this to say: “As a regulator and supervisor of banking institutions, in collaboration with other federal and state agencies, we must help ensure that our financial system remains both stable and efficient. Our financial system is without doubt far stronger and more resilient than it was a decade ago. Our banks have much higher levels of capital and liquid assets, are more aware of the risks they run, and are better able to manage those risks. Even as we have worked to implement improvements, we also have sought to tailor regulation and supervision to the size and risk profile of banks, particularly community institutions. We will continue to consider appropriate ways to ease regulatory burdens while preserving core reforms–strong levels of capital and liquidity, stress testing, and resolution planning–so that banks can provide the credit to families and businesses necessary to sustain a prosperous economy. In doing so, we must be clear and transparent about the principles that are driving our decisions and about the expectations we have for the institutions we regulate.”

On this issue, he is probably very close to Yellen, however he is presenting a more business-friendly face. He wants to ease regulatory burdens where appropriate, and to give (hopefully) brighter lines about what the regulators want than previously.

The issue of regulatory transparency falls along two schools of thought. First, the attitude of the Obama administration (and many regulators on the left) is that regulators should disseminate general principles and not specific guidance (bright lines). Their logic is that the financial sector will figure out a way to game the system, so the easiest way to prevent that is to make the lines so blurry that bankers will not approach them. It definitely makes the system safer, however the downside is that compliance officers end up running the banking system. Most bankers refer to compliance as “the business discouragement unit” because the incentives for compliance offers are to focus solely on the downside. It makes banks risk averse and therefore restricts credit.

The attitude of those on the right is that there are diminishing returns to that framework in terms of safety at the expense of credit expansion (and overall economic growth). So their view is to give the banks brighter lines so that the lawyers (who are risk averse) are no longer making the capital allocation decisions. The plus side is higher growth, however the downside is that banks game the system and take too much risk.

I suspect both Yellen and Powell are pretty similar in their regulatory approach, but Powell will probably be a touch more banker-friendly. Of course for the banking sector, the Fed is just one regulator, and they have all the state regulators, plus the CFPB to consider so any change will probably be minor if recognizable at all. So punch line: don’t expect to even notice the difference between Powell and Yellen.

In other news, home prices continued to rise in September, with the FHFA house price index up 0.3% MOM / 6.3% YOY and the Case-Shiller index up 0.5% MOM and 6.2% YOY. While the Pacific and Mountain states continue to experience strong growth, we are seeing a pickup in New England and the Middle Atlantic states. These are the judicial states which still have been still working through their foreclosure inventory.

Inventories fell at both the retail and wholesale level in October, which means Q4 GDP will start off with an inventory drag. Note we will get the second revision to Q3 GDP tomorrow morning.

The Senate continues to work with tax reform. Here are the 8 Senators who can make or break tax reform and what they are looking for. In one group are the deficit hawks. The CBO estimate is that this will add $1.4 trillion to the national debt, before taking into account any improvement in growth. Some are looking for some sort of trigger that will bump tax rates back up if the revenue is not there. Others worry about the effect tax rate uncertainty will have on corporate behavior. Another group worries that tax reform will benefit large multinational corporations at the expense of small business. And finally, there are the ones that don’t support eliminating the individual mandate in Obamacare to fund tax cuts (Collins and McCain). The inability to repeal and replace Obamacare is making tax reform so much more difficult. We’ll see what happens, but I suspect we can’t thread the needle here.

Morgan Stanley is advising clients to bet on a yield curve flattening via the 2 year and 10 year spread. Right now the 10 year is trading at 2.32% and the 2 year is at 1.74%. They are forecasting that the difference in yields (currently 58 basis points) will go to 0 next year. Continued demand from global central banks will support demand for government debt to begin with, and if growth comes in stronger than expected, short rates will increase faster. If growth comes in lower than expected, then demand for duration will keep the 10 year yield low. Note this strategist at Morgan Stanley is a huge bond bull, and was calling for a 1% 10 year bond in 2016 before the surprise election of Donald Trump destroyed that forecast.

Morning Report: The CFPB has two directors 11/27/17

Vital Statistics:

Last Change
S&P Futures 2601.0 0.0
Eurostoxx Index 385.7 -1.0
Oil (WTI) 58.3 -0.7
US dollar index 86.2 -0.2
10 Year Govt Bond Yield 2.33%
Current Coupon Fannie Mae TBA 102.651
Current Coupon Ginnie Mae TBA 103.494
30 Year Fixed Rate Mortgage 3.9

Stocks are flat this morning after the US comes back from a long weekend. Bonds and MBS are up.

Retailers are rallying this morning on expectations of a strong holiday shopping season. Meanwhile, Bitcoin is pushing $10,000.

New Home Sales rose 6.2% MOM and almost 19% YOY, according to Census and HUD. The median sales price was $313k, while the average was $400k. Inventory is at 4.9 months’ worth.

We have a good amount of data this week, although the jobs report will not be released this Friday. We get new home sales today, house prices tomorrow, GDP on Wednesday, Personal Incomes / Spending on Thursday, and the ISM data on Friday. Janet Yellen will also speak on Wednesday.

Richard Cordray resigned from the CFPB last week and Donald Trump nominated Mick Mulvaney to lead the Bureau. Outgoing Director Cordray nominated Obama appointee Leandra English (a career civil servant in the Elizabeth Warren mold) to replace himself and the agency is suing the Trump Administration to prevent him from nominating Mulvaney. So, for the moment, the agency has two directors.

While there is partisan rancor over who will lead the CFPB, Trump’s nominee to lead the Fed, Jerome Powell, expects to have a smooth path to confirmation.

Tax reform will be front and center this week as the Senate hopes to vote this Thursday. If the Senate passes a bill, the House and the Senate will need to come to an agreement between their respective bills. Trump hopes to sign something by the end of the year.

Who would be the biggest losers in the tax bill? The very rich in Greenwich, CT and Manhattan. This is the last thing Connecticut needs – their entire state is largely financed by the rich in Fairfield County. Goldman Sachs estimates that NYC could lose 4% of their top earners. The most likely beneficiary? Florida. The rarefied air of the Northeast luxury market will take a hit (it was already moribund before people were talking about eliminating the state and local tax rate), although inventory is so tight it probably won’t affect the lower price points.

The NAR has released a study claiming that tax reform will hit real estate prices overall by 10%. The fear is that it will discourage homebuilding which will sap the economy of strength. It is true that economic growth has been tepid over the past decade as homebuilding contracted, but will the changes in the tax code matter all that much? I am skeptical that lowering the MID cap from $1 million to $500k will matter all that much, given the median home price in the US is under $250k. The median income in the US is under $60k as well and most people will be better off just taking the increased standardized deduction. So while they may “lose the mortgage interest deduction” it is a moot point – the increased standard deduction replaces it. But yes, I would expect to see some sort of effect at the top 10% of the market, but that should be about it. As far as homebuilding, I think the builders will shift their focus from luxury to starter homes, where the demand is. As a matter of policy, if you wanted to get rid of the mortgage interest deduction when it causes the least amount of economic pain, you would do it when the economy is expanding and interest rates are low. Interest as a percent of your mortgage payment is the lowest in 50 years.

Madness in the Method?


Uber has ordered 24K self driving Volvo SUVs.

Forget that self-driving without a human monitor is not legal in most jurisdictions.  Assume Uber can rapidly obtain local approval for self driving vehicles. Assume it can cut its labor cost and sidestep its pending fight over whether its drivers are contract or employee.  Assume that by developing its own software controls for these Volvos it can customize successfully to locale and traffic patterns.

What I see is this:  Uber is banking its future on an asset base that will be pretty much worthless in 3-5 years.

I see that as a billion dollars blown every three years.  I see that as Uber having to build and staff and manage its own expert maintenance yards because it is using proprietary software, or having to contract that out at a premium.

It might be a workable model, but it is a HUGE gamble.  Yes or No?





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